What to Expect from Inventory Optimization

17 May 2017

Seven Easy Estimates
Reveal What to Expect from Inventory Optimization

The
first step toward successful inventory optimization is getting your internal
conversation on the right track by assessing your current situation,
understanding the potential benefits, and setting your expectations with
confidence. The benefits of multi-echelon inventory optimization (MEIO) have
been well established by hundreds of companies of all sizes in industries
ranging from consumer products to life sciences, high technology to process and
discrete manufacturing. Leading organizations have shown that right-sizing
inventory buffers and restructuring where and how inventory is held drives
powerful financial benefits and adds tremendous value to the sales, inventory
and operations planning (SIOP) process. MEIO provides a knowledge platform for
better decision making and lets organizations use inventory as a lever for
balancing supply and demand. Supply chain managers seeking to assess the
potential financial benefits of an MEIO initiative can start with the
high-level process outlined here. Based on our years of experience, this paper
presents a good way to get the ball rolling, with seven simple estimates that
help explore the impact an MEIO initiative can have on your organization.

Types
of Inventory Available for Optimization

Optimizable
inventory includes finished goods, work-in-process, raw materials, components
and service parts. Inventory buffers that are held as a hedge against
uncertainty in demand or supply are a primary source of excess and optimizable
inventory. This safety stock can be dramatically reduced through MEIO. Not all
inventory is available for optimization. One example is in-transit inventory
that resides on boats, trains, trucks and planes. Other forms of inventory not
available for optimization include stock that was produced but is not expected
to sell, pre-built/promotional inventory that has been pre-positioned to handle
business cycles, and pre-ordered inventory. The MEIO conversation starts by
calculating what percentage of the supply chains total inventory is
optimizable. This lends credibility to real-world benefit estimates.

Benefit
Streams of MEIO

Based
on years of actual results achieved by companies worldwide, it’s clear that the
benefits of inventory optimization vary across industries and businesses. The
financial impacts of MEIO span several one-time and recurring benefit streams:

One-Time Benefit

Inventory
Reduction: Optimizable
inventory can typically be reduced by 10% to 30% by rightsizing inventory
buffers held at all stages, or echelons, of the supply chain. MEIO programs
normally reduce overall inventory while meeting or improving service levels.

Recurring Benefits

Increase
in Working Capital: As
the amount of on-hand inventory drops, it frees up the cost of capital that
would otherwise be trapped by that inventory. This is a net recurring benefit
equal to your cost of capital multiplied by the value of the eliminated
inventory.

Reduction
in Logistics Costs: The
total logistics burden includes costs for warehousing, insurance, labour and
expedited shipping, among others. Eliminating inventory eliminates its
associated logistics cost, which can amount to 10% of inventory value.

Reduction
in Write-offs: Obsolete
inventory is a write-off. Most companies can expect MEIO to save a portion of
the cost of goods sold (COGS) of optimizable obsolete inventory. Savings can
range from a few percentage points to substantially higher for companies with
many new product introductions or high rates of product churn.

Reduction
in Stock-outs: Shortages
and stock-outs cause both fulfilment delays and permanently lost revenue due to
cancelled orders. MEIO can reduce the percentage of permanently lost orders
within your optimizable inventory by a significant amount typically a
double-digit reduction. Lowering the lost order rate results in higher revenue
generation.

Seven
Easy Estimates of MEIO Potential

Inventory
optimization drives both one-time and recurring benefits. The typical ranges
used to estimate these benefits can be narrowed down for your unique supply
chain by assessing the key factors below. Give your business a rating of low,
medium or high in each of the following areas:

1. Level of Demand
Uncertainty

To
what degree does your company face highly variable, hard-to-forecast demand?
Alternatively, is your demand signal very predictable, or do you consider
forecast accuracy not a significant problem?

2. Supply Chain
Complexity

A
good starting point for assessing complexity is to consider four factors: your
supply chain length (replenishment lead time) in days, the number of supply
chain stages (echelons), the number of locations holding optimizable inventory,
and your annual rate of SKU turnover. Lead times over 50 days typically
indicate high complexity.

3. Current State of
Inventory Optimization Maturity

Does
your organization rely primarily on rules of thumb, such as 30 days of forward
coverage for all items? Do you perform single-stage inventory optimization in
some parts of the supply chain? Does your company have any experience with
MEIO?

4. Presence of Long
Lead Times

Comparing
yourself to others in your industry, are your lead times of comparable length
or longer? Are lead times highly variable or unpredictable?

The
combination of a one-time reduction in inventory and multiple streams of
recurring benefits reinforces the fact that multi-echelon inventory
optimization affects many aspects of supply chain performance and delivers
financial benefits above and beyond the freeing up of working capital.

Companies
must take an organized approach to estimating and calculating each individual
benefit stream. Information you will want to have on hand includes:

1.Optimizable on-hand
inventory (based on the value of inventory on hand and the percentage of
inventory available for optimization)

Lost
Order Recovery: Annual
sales revenue lost permanently due to unfilled orders x estimated reduction in
lost order rate achieved by MEIO.

Reduction
in Obsolescence Cost: COGS
of unsold inventory x estimated savings from reduction in obsolete inventory
due to MEIO.

Conclusion

Multi-echelon
inventory optimization right-sizes inventory buffers and recommends where and
how inventory should be held across all tiers of the chain. MEIO initiatives typically
reduce inventory by 10% to 30% while improving service levels, resulting in
dramatically improved profitability and happier customers. Significant
recurring benefits include:

·Increase
in working capital

·Reduction
in logistics cost burden

·Savings
from lower obsolescence

·Revenue
uplift from fewer permanently lost sales orders

Estimating
these recurring benefits for your individual business is a powerful place to
start the internal conversation. Supply chain teams interested in exploring and
refining these benefits can begin by looking at the seven easy estimates we ve
outlined in this paper. It s a good first step toward building a solid business
case for
MEIO.

Article
contributed by Logility. The original article can be found at www.logility.com

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